On Sunday, 20 July, Dragon TV of Shanghai, China, precipitated a reputation crisis at two global companies. The TV station reported that food supplier Husi, owned by OSI Group of Aurora, Ill., repackaged stale beef and chicken, updated the expiration dates, and sold the adulterated meat to McDonald's, KFC and Pizza Hut restaurants.

A reputation crisis begins when a company fails properly to set expectations or fails to meet them, and then stakeholders turn on a company and lower their expectations. The going-forward economic consequences result from how customers thereafter respond to prices, how effectively employees work, creditors set borrowing rates, suppliers set terms, and how severely regulators impose penalties.

For Yum Brands and McDonald’s, the changes in stakeholder expectations are reflected in customers’ reduced demand--or at least some analysts expectations of future customer behavior. Royal Bank of Canada analysts projected that Yum’s China sales at KFC and Pizza Hut could drop off 10-15% for at least 6-8 weeks after the July event. An executive at McDonald’s Japan reported a 15-20% drop-off in daily sales. Forward-looking equity investors are seeing more sustained losses. Between July 15 and August 14, Yum! Brands equity lost 15% of its value; McDonald’s shed around 7%, and the benchmark S&P500 composite equity index lost about 1.2%.

[Added Saturday 16 Aug] A more encompassing view of expected stakeholder behavior shown below, according to analysis published by Consensiv, the reputation controls company, based on reputation value metrics we use at Steel City Re, affirms that all-things-reputationally at McDonald's are not as bleak as equity investors might be signaling. The company's reputation premium is near the top (and heading upward), and its value risk is in the lowest quartile of its peer group.

Post a Comment

"It was hardly a quiet week at Lake Reputation-be-gone," Garrison Keeler might have said. "Walgreen, McDonald's & Yum!, and current poster-child GM had their respective moments in the sun...again."

Walgreen's issue is an ethical one. The company whose motto proclaims it to be "the pharmacy that America trusts" would just as soon not pay America $4 billion in taxes over the next five years. The company is now deciding whether to take advantage of the US tax law loophole that would reward it substantially with a lower tax base were it to acquire controlling interest in a Swiss-based company and nominally relocate its headquarters overseas.

McDonald's and Yum! were apologizing for supply chain issues that again raised questions of food quality and safety in the Chinese operations. Earlier this week, Chinese regulators closed the Chinese division of an Illinois-based good supplier (OSI) after a TV report showed workers picking up meat from a factory floor and mixing expired lots with fresh lots of meat. Upton Sinclair would have been proud.

GM announced six additional automobile recalls this week bringing its total for the year to 60 announcements covering 29 million cars worldwide. Quality and safety issues are at the forefront, but they are not all associated with supply chain failures. Some, in fact, are due to assembly and integration issues in GM's wholly-owned operations.

As is the case after every major operational issue, the press is making much ado about the damaged reputations of these firms. The events are certainly news-worthy and embarrassing. Whether they cause stakeholder to reassess their respective relationships with the companies, however, is the central issue in a reputation crisis.

Walgreen's issue is unlikely to have any effect on most stakeholders. Equity investors will be thrilled, and creditors equally so. Legislators are unhappy, but it is not clear their opinion matters much since they have proven their inability to do much of anything.

This is Yum!'s second bout of China-related supply chain safety and quality. The toxic chickens of 2012/2013 gave them quite a reputation scare, which is why they may have dumped OSI like a hot pan. McDonald's is new to this type of crisis and is sticking with OSI. Also, McDonald's maintains qualitatively different types of relationships than Yum! with its suppliers. By forgiving OSI, McDonald's is demonstrating the benefit of OSI's historically stellar reputation…to OSI.

GM is now in a league of its own. Credit the company with fabulous spin control by declaring that Wednesday's additional recalls signified how the company had enhanced its approach to safety.

Post a Comment

Once upon a time, it seemed that Yum! Brands (YUM), Yankee imperialists by almost any other name, were going to win the hearts and minds of the populace of the Middle Kingdom. Fast forward, and the Economist's February 2013 label, "Yucky Kentucky" seems to be taking hold.

The current chapter began about one year ago when a media report on China's national TV station alleged that some poultry farmers in KFC's supply chain violated both Chinese regulations and Yums! supplier terms by doping chickens to speed up their maturation and marketability.

"Toxic chickens!" The Chinese, who've had their fair share of food-associated mortality, apparently shunned the branded products. KFC’s January sales in China fell by a dramatic 41 %. Regulators made recommendations, Yum! took them to heart, and importantly, acknowledged the relationship between its operations and its reputation in its 2013 annual report.

Cultural, geographical and legal distance make it very difficult to first perceive and interpret early warning signals correctly and then to react quickly and appropriately. One spin on the January 2013 fall in sales, and the September 2013 report of a 70% fall in net income, is that Yum!'s reputation in China has been permanently damaged by the affair.
The narrative fits the "hero to zero" story and Warren Buffett's adage about losing a reputation in five minutes after a life time of investment.

But solid reputations exhibit resilience, unless...

Yum! doesn’t operate under the usual franchise system in China. It owns most of its stores -- approximately 5000 restaurants in 800 Chinese cities. Yum!'s success provides less local benefits at a time when the domestic economy is struggling. A plausible alternative explanation for Yum!'s woes is more political: the company is being tagged with the stigma of being an imperialist monster that has no respect for the local environment and whose only interest is exploitation of the local market for domestic economic purposes.

Cold war diatribe? Consider last week's accusation by China's state-controlled media that Starbucks Corp (SBUX) charged too much for coffee and that Samsung Electronic Co.'s smartphones don't work properly. Suppose that toxic chickens, or red herrings, are only the tip of the iceberg of regulatory interference -- a heavy handed effort by Chinese authorities to turn around a flagging economy by encouraging domestic consumption.

After 10 years averaging 10.5% growth in the prior decade, China has pared economic growth projections to an average of 7 percent this decade. That's arguably optimistic. Besides a property bubble arising from credit expansion, the entire economy's debt burden is in the same vicinity that preceded crises or sharp slowdowns in Japan and other Asian nations. Even after adjusting for inflation, wages have tripled in the past decade.

According to Bloomberg, "When the U.S.-China Business Council, a Washington-based trade group, surveyed U.S. executives this month, the chief complaints included rising costs and bureaucratic red tape. Almost 70 percent of the more than 100 U.S. firms polled said profit margin would be flat or narrow this year. Only 39 percent are optimistic about the next five years in China; 58 percent felt that way in 2011."

Governments have an uncanny ability to reorient stakeholder expectations. Central bankers have been performing this magic for more than a year with respect to the credit and equity markets. It was not the fire, loss of life, nor oil spill of the Deepwater Horizon that escalated the disaster to the level of the board of directors. Rather, as Carl-Henric Svanberg, Chairman of BP, declared in May 2010, "This has now turned into a reputation matter, a financial squeeze for BP, and a political matter…"

The reputation metrics for Yum! reflect the battle for the hearts and minds of stakeholders, and the power of government to reset those expectations in a heartbeat. The consequences are clear: substantial loss of Reputation Premium from the top percentile among the 65 companies in the restaurants sector to the 70th percentile; and significant confusion in stakeholder expectations evidenced by a top quartile measure of uncertainty - the Consensus Trend -- at 5.2% equaling the two year average level of reputational value uncertainty, the Consenus Benchmark, also now at 5.2%.

For more background on the Consensiv reputation controls, click here. To view the October 2013 reputational value league table at CFO.com, click here.

Comments

Post a Comment

Reputation is the confidence stakeholders have that a company will fulfill expectations. A reputational value crisis arises when a company fails to do so and stakeholders realign their expectations.

Last year, Yum! Brands' supply chain quality control processes failed and toxic chickens were served through their KFC outlets in China. The problem has come home to roost. From yesterday's Associated Press wire story, "KFC's parent company Yum Brands says its profit fell 68% in the third quarter, as its China unit struggles to recover from a controversy over its chicken supply and bird flu scare. Results missed expectations and Yum lowered its outlook. Shares fell 6% in aftermarket trading."

Expectations of food quality appear to be near-universal, and customers the world over, provided they have a choice, will do just that: choose. For the time being, Yum! is not top choice.

Comments

Post a Comment

Whether the market rewards or punishes a company depends on what the market expects, according to the book Reputation, Stock Price and You. This week's news on YUM! Brands is illustrative.

From Reuters, good news as sales only fell 20% as a result of the toxic chickens disclosure.
KFC parent Yum Brands Inc reported an unexpected 2 percent rise in February sales at established restaurants in China, boosted by Chinese New Year and easing worries about a food safety scare that drove away customers. Shares in Yum jumped 6.6 percent in extended trading to $72.32, their highest level since November, after the results were far better than the estimated 8.7 percent drop expected by three analysts polled by Consensus Metrix. Yum also said on Monday first-quarter same-restaurant sales in China fell 20 percent, less than its prior forecast for a 25 percent drop.

Also from Reuters, more good news as Chinese appear to be less overtly angry -- or at least they're not talking about it.
Chinese consumers' anger at KFC over a food safety scare has abated as the number of negative posts about the fast food chain owned by Yum Brands Inc on the country's most popular microblogging platform fell by two-thirds.
China's half a billion microbloggers posted 3 million overwhelmingly negative comments about KFC in the month that began on Dec. 18, when state media started reporting on the scare over contaminated chicken, a Reuters review of data from the Twitter-like platform Weibo shows.
The number fell from Jan. 18 to Feb. 18, but microbloggers still posted more than 1 million comments on KFC, indicating that the largest foreign fast food chain in China still has its work cut out for it as it tries to reverse a steep sales slide.

The Steel City Re reputational value metrics provide an integrated view of expectations and the economic consequences of the behaviors arising. The data on YUM show that the company's arch rival, McDonald's (MCD) has benefited from the turmoil. By all of the reputational vital sign measures, MCD advanced. Both companies are at the low end of the spectrum of historic RVM volatility. RVM is a non-financial measure of reputational value. The absolute measures are in the 4-5% range, which on an actuarial basis place YUM at an imperceptibly higher risk of material future market value loss. The current RVM volatility of MCD is also greater than YUM and is attributable in part to the significantly greater rise in ROE. The levels for MCD and YUM on the former measure both suggest a better than average future course. On these two measures, as well as the CRR, a measure of relative reputational ranking, MCD has benefited from YUM's slide. Going forward, the data suggest that many customers will come back. It is not clear, however, if equity investors are not getting to far ahead -- a variation on a parent's admonition take care lest one's eyes turn out to be bigger than one's stomach.

Everybody has problems. Boeing has an airplane problem. Tesco has a hamburger problem. And YUM! has a chicken problem. Three different commercial sectors each with quality problems, often leading to safety issues, with one common element. All of the problems originated within the companies' supply chains, comprise failures in operational oversight and control, and have the potential for blossoming into full-on reputational crises.

Reputational crises are expensive. Customers slow down their purchase frequency and extend the their purchase decision cycle, to say nothing of their resistance to premium pricing. But the pain goes further. Vendors offer less favorable terms; creditors raise the cost of capital, employee turnover is but one indicator of morale problems that start brewing, NGOs take interest, and regulators start paying more attention. And of course, equity investors, who have the shortest fuse, sell. That is why Huygens prefers to call them, "reputational value crises."

CNBC reported yesterday that Yum Brands, the parent of restaurant chains Taco Bell, KFC, and Pizza Hut, reported surprise weakness in China. "This skews to the worst case for the company," said David Palmer, managing director and senior food & restaurant analyst at UBS, who covers the company. China represents almost half of the business, in profit terms, for the company, he said in an interview on CNBC's "Squawk on the Street."

Forbes reported, "At YUM’s analyst day on December 6, 2012, we asked CEO David C. Novak what his “defense” was to media exposes that one of KFC China’s suppliers had pumped its chicken full of chemicals to expedite their growth. The story prompted a furious social media reaction. His answer was “No worries. It will blow over.” When asked how, he shrugged: “It always has.”

Turning to a measure of reputational value, the Steel City Re reputational value metrics, the measures for YUM! in contrast to McDonald's, the sector reputational leader, are informative. The problem, it seems, hasn't blown over. The company's reputation ranking is sinking steadily and the forecast last week as shown below, before this week's news, was for further deterioration. The steadiness of the deterioration was suggested by the RVM volatility measures and the median forecast stability numbers. RVM, as Huygens' followers know, is a non-financial measure of reputational value.

YUM!'s loss would reasonably be expected to by McDonald's gain. MCD, with a CRR, a measure of relative reputational ranking, buried at 1.0 for the sector, could only gain in RVM. MCD's RVM volatility suggests this is the case, and not surprisingly, its ROE has been climbing as YUM!'s has been sinking.

The moral: supply chains are great sources of cost savings, value, operational risk, and reputational value risk. Their operations need to be overseen and controlled no less so than organic operations. And if the excuse is that the whole point of outsourcing was to reduce the costs associated with organic controls and oversight, well, then, add that sentence to the ever-growing collection of things that seemed like a good idea at the time.

Comments

Post a Comment

Shares in YUM! Brands fell earlier this week, but the Steel City Re Reputational Value Metrics show that the damage was done some weeks ago (see spike in chart column 2, row 1). This sudden upwards movement in the company's Current RVM volatility was triggered by news reports that the chicken in the company's flagship product, KFC, was contaminated. RVM, a non-financial measure of reputational value, is volatile. Spikes in volatility are often associated with subsequent sharp market value changes. The charts compare and contrast YUM! with McDonald's Corporation, a premier manager of supply chains described further in the book, Reputation, Stock Price and You.

Back to our toxic chickens. As the FT explains:
In November, Chinese media accused Su Hai Group, one of the chicken suppliers to KFC (Yum’s flagship brand in China with 3,700 outlets), of injecting antiviral drugs and growth hormones into poultry in ways that violated mainland food safety regulations.
This was followed by a CCTV report a month later that accused another KFC supplier, Liuhe Group, of similar practices that helped accelerate the growth cycle of the chickens from 100 days to just 40 days.
Shortly after the TV report aired, the Shanghai Food and Drug Administration (SFDA) said it found that eight of the 19 batches of chicken samples Yum sent to a testing laboratory in 2010 and 2011 contained overly-high levels of antibiotics.

Post a Comment

The Wall Street Journal reported yesterday that McDonald's Corp. (MCD) surprised investors by reporting higher November sales. Analysts, according to the Journal, remain cautious about the months ahead. Credit for the gain goes to the Company's Dollar Menu which "helped reverse a downward slide from the month before, when McDonald's posted the first drop in monthly same-store sales in nine years. Same-store sales globally rose 2.4% in November, fueled by a 2.5% rise in U.S. same-store sales. Analysts were expecting sales to be flat around the world."

McDonald's can afford to deliver its Dollar Menu because the company runs one of the best supply chains in the world. As described in Reputation, Stock Price, and You, "[McDonald's] approach to its relationship with suppliers reflects its ethical culture and the innovations Kroc brought to the business." Among the benefits of the Company's strategy are net lower costs--benefits the suppliers grant McDonald's that we now call reputaitonal value.

Turning to the Steel City Re Reputational Value Metrics, the improved returns are obviously welcomed, but are less surprising. For the trailing twelve months, McDonald's has steadily ranked #1 among the 64 companies in the Restaurant and Fast Food Franchisers sector.

Weighing in at more than twice the size of its closest competitor, YUM! Brands, the company has to work much harder to grow. However, its phenomenal operational controls mitigate risks that might cause it to stumble, so when its CRR--a measure of relative reputational ranking-- hugs the #1 spot for a year while its ROE plummets, one can reasonably expect a turnaround. The data forecast a steady state for McDonald's with respect to key reputational metrics, the RVM and the CRR. And so while Yum! enters a turbulent reputational period, expect McDonald's equity investors to relax and return to the fold.